Rudi's View | Apr 19 2007
This story was first published two days ago in the form of an email sent to registered FNArena readers.
By Rudi Filapek-Vandyck
The public debate about the shape of the Commodities Super Cycle from here onwards remains an open question with a majority of economists counting on a significant weakening of the US economy in the months ahead. This will impact growth elsewhere and thus global demand for base materials.
No wonder thus the majority of securities analysts are currently forecasting most prices for base materials will weaken in the second half of 2007. It is these experts’ view that the Super Cycle will reveal itself in the fact that even though prices for the likes of copper, nickel and tin will fall from their current elevated levels, they will still remain significantly above price levels that characterised the early years of the new millennium.
As pointed out in previous stories already, certainly not everybody subscribes to this view. In copper for instance, experts at GSJB Were and UBS stand firm in their conviction the spot price will not fall materially from current levels, even though most other experts say they cannot match current prices with underlying market fundamentals.
A similar story is unfolding in the nickel market. Canadian experts at Canaccord Adams recently released an industry report which, in a nutshell, carried one main conclusion: most experts are wrong in their assumption that the tide will soon turn for nickel prices. Says Canaccord Adams: “Significantly high nickel prices will be required through the end of this decade to reduce forecast consumption levels, in line with available inventories”.
While this debate is far from decided, one commodity appears to be gradually winning over all experts in the market: iron ore. Similar to nickel and molybdenum, demand for iron ore is closely related to global steel, in particular Chinese steel production. So far demand and prices for steel products have surprised the sceptics. This has translated itself into higher than expected spot prices for the likes of nickel and molybdenum.
Most contracts for iron ore are decided through annual negotiations between the three major producers and their largest customers in Asia. The spot price is only of secondary importance (and even that is debatable) and this means that iron ore is unlikely to catch many people’s attention in between the annual negotiations, unlike other commodities.
This does not take away the fact that market experts are increasingly warming towards iron ore’s price prospects. After the big three producers managed to negotiate a stellar 71.5% price rise for JPY06, followed by a further 19% rise for JPY07, most experts were convinced the world had seen the all-time high for the commodity.
Surprisingly, however, negotiations at the end of 2006 (for the Japanese fiscal year starting in April 2007) led to another price rise -up 9.5%- and this time without the previous fierce Chinese opposition.
Since then many expert in the market has started to look differently at this market. As a result, price expectations have been trending up since February. Most experts seem to agree, for the time being, that the next round of negotiations, for the year starting 1 April 2008, will again see a further price rise of 5-10%. Several experts have started pricing in continued tight market dynamics for several more years to come.
Even those experts who have yet to adjust their modelled prices to the new market consensus seem to agree: more and more signals are pointing towards continued upside for iron ore prices.
This week saw analysts at Credit Suisse and Deutsche Bank update their market views. Both expert teams see risks skewed to many more years of higher than expected prices. The title above the Deutsche Bank report can serve as the perfect summary of the experts’ revised view: it’s a long term bull market.
A few recent developments have added to the overall change in market sentiment. Steel manufacturers have positively surprised in pushing prices up again in 2007 following some price weakness in the second half of 2006. Given the relentless growth of Chinese steel production and exports, this can only be regarded as a major feat.
Equally important is that major production disruptions have prevented producers from achieving projected output levels. In Australia both Rio Tinto (RIO) and BHP Billiton (BHP) were forced to suspend production for a week in mid-March due to cyclone George. Emerging producer Fortescue Metals (FMG) has also indicated it is likely to experience delays to its start up scheduled for 2008.
However, the key change that is likely to have tilted the industry dynamics in favour of the producers for several more years to come is the introduction of export taxes on iron and chrome ores and concentrates by the Indian government in March this year. The taxes are meant to safeguard the Indian government’s ambitious growth plans for the local steel industry by keeping more input commodities inside the country. As a result of this, Indian exports to China are widely expected to drop and this will see Chinese buyers pay higher prices in the following years.
Deutsche Bank analysts formulated it as follows: “It is hard to conjure up a scenario where demand growth would ease back so suddenly, let alone fall, to cause a shift in fundamentals as to warrant a large market imbalance and consequent price falls in contract prices.”
Similar to commodities such as uranium and molybdenum, the unforeseen industry dynamics for iron ore have triggered a worldwide frenzy in the development of new projects. From India to Brazil, to Mauritania, Sweden, South Africa and Kazakhstan potential iron ore mines are being financed and developed. But more so than for any other commodity, bringing an iron ore project into full production requires time, often lots of time. That’s because of the large infrastructure requirements that come with these projects. (Not to mention the cost blow outs many are experiencing.)
According to some experts, there are currently more than 50 iron ore projects in various stages of study and development in Western Australia alone. Most of these projects are likely to require shared access to infrastructure and this could well become a major barrier to further development.
The future of iron ore remains subject to many uncertainties that may yet impact the current market dynamics. One point of uncertainty remains the level of Chinese domestic production (even though the iron content of Chinese ore is mostly only 30% compared with 57-65% for Brazilian and Australian ore).
Another scenario that could change the market dynamics would be if every planned project expansion and new mine would come on line according to schedule. Recent history shows this is rather academic as delays seem but normal, especially at times when additional skilled labour and equipment within the mining industry are scarce.
On Deutsche Bank estimates the industry is facing a production shortfall of some 80m tonnes outside the big four producers by 2010. The figure could well be larger depending on future developments in India and China.
The Casa de Pedra mine in Brazil is scheduled to produce 53m tonnes by end 2010. Incorporating a ramp up delay to 2009 for Fortescue Metals (not confirmed by management yet) could add a further 45m tonnes by then, indicating the market balance could well shift in favour of the buyers from 2010 onwards.
Other potential projects across the globe represent an estimated additional supply of 150m tonnes per annum, but only a few smaller projects are scheduled to come on line this year. Among them are OneSteel’s (OST) Project Magnet (4m tonnes), Gindalbie Metal’s (GBG) Blue Hills project (4m tonnes), Mount Gibson’s (MGX) planned extension (5m tonnes) and Midwest’s (MIS) planned 4.5m tonnes per annum.
Outside Australia steel producer Mittal is expected to add up to 15m tonnes and a smaller start up in Kazakhstan could well add another 3m tonnes.
China is expected to buy close to 50% of all seaborne iron ore this year.